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Roth IRA Rules - Conversions, Rollovers, Re-Characterization

H Craig Rappaport
 


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Beginning as of January 1st, 2008, a plan participant may now directly rollover from eligible retirement plans (including all qualified plans, 403(b) and 457(b) plans) to a Roth IRA, subject to Roth IRA limitations. The conversions for 2008 are only available to taxpayers with $100,000 or less in adjusted gross income (AGI), as in prior years.

Taxpayers should be aware that the actual conversion process is not tax-free. The taxpayer must include in gross income the taxable portion of the conversion amount; but they are not generally subject to penalties for premature distribution.

Given the difficult market environment during 2008, now may be a particularly attractive time to consider a Roth conversion. Since the Roth conversion is in itself a taxable process, the taxpayer would benefit from converting securities now that may represent a lower valued basis on which the taxes are assessed. If a taxpayer has already made a Roth conversion in 2008, and experienced a loss in portfolio market value, there may be an opportunity to benefit from a Roth IRA Re-characterization. In a re-characterization, the conversion/contribution is effectively undone; the assets are shifted from the account which received the initial contribution/conversion to the account which will subsequently maintain the assets.

There may be several reasons for a re-characterization, including a failure to meet Roth eligibility requirements (Modified Adjusted Gross Income in excess of $100,000 for example, or an individual who has elected to file Married Filing Separately), conversion of required minimum distribution amounts due on the IRA or a failure to meet the 60-day rollover contributions.

If the conversion took place during a year of significant market declines, a re-characterization back to an IRA and then a subsequent, later conversion may result in less tax. Caution must be exercised in re-characterizing, and then later reconverting, as a failure to follow the time guidelines can create a failed conversion as a Premature Reconversion. The general rules are that a taxpayer must wait until the later of either the beginning of the year following the year in which the conversion occurred or thirty days after the re-characterization is completed. Also, because gains in a re-characterized account may create tax problems in earnings on excess contributions, the taxpayer should consult with their tax advisor to see if re-characterization may be a worthwhile opportunity.

If you are not currently eligible to make a deductible contribution to an IRA or a Roth contribution, now may also be a good time to consider making non-deductible contributions to an IRA in anticipation of converting the proceeds at a future date to a Roth IRA. If you do so, then the only taxable portion of the conversion would be the appreciation of holdings being converted. In 2010, the AGI limitation for Roth conversions will be lifted, making then a good time to consider conversion.

There are some complications if the taxpayer has other traditional IRA accounts, so this primer should only be the first step in your investigation regarding your transactions. Please consult with your tax advisor before considering conversion to a Roth IRA. Mistakes may be costly and irreversible.

Visit http://www.livelongliverich.com for the latest information on retirement issues, planning and income generation.

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